The argument against reverse mortgages

DEAR BENNY: I hope you enjoy a good discussion as much as I do, as I'm going to try to convince you that a reverse mortgage is more than a last resort. Let's look at a 70-year-old who has been very comfortable in his retirement, collecting Social Security and withdrawing 4 percent from his $500,000 portfolio.

Unfortunately, his portfolio has lost 40 percent of its value, is now worth $300,000, and in order to maintain his income he now has to withdraw 7 percent. We both know that by withdrawing 7 percent that $300,000 will go fast. Why not enter into a reverse mortgage, leave the portfolio alone so it can have a chance to recover, and use the equity in the home (tax-free dollars) to make up the income from the portfolio?

When the portfolio has recovered a bit, stop using the equity and return to the portfolio, keeping in mind the equity not used in the reverse mortgage is in a growing line of credit that is available at anytime for any reason. --Stephen

DEAR STEPHEN: I always enjoy a good discussion -- and even a good argument. After all, I am an attorney by profession. You raise a good point, but I still believe that a reverse mortgage should be considered only as a last resort. Perhaps, in your example, it is a last resort for that gentleman who lost a lot of his retirement income.

Quite recently, John Dugan, U.S. Comptroller of the Currency, warned that "the ability of consumers to access their home equity through immediate and large-sum payments can pose substantial risks."

What are these risks? Misleading and deceptive marketing is one. Another is that some reverse mortgage borrowers have not kept current on their insurance and real estate taxes, thus leading to more foreclosures.

And, perhaps most significant, the upfront fees and charges are very high and in your example our gentleman would be losing a lot of his equity just on those costs alone.

And now a word of caution for anyone considering a reverse mortgage: Make sure you fully understand all of the terms and conditions, and don't be persuaded to buy insurance or other annuities with the moneys you receive through this type of loan.

DEAR BENNY: I bought my condo 11 years ago. This was the first home I ever owned. Do I pay taxes on the sale? I am not counting on paying any taxes; does anyone have this information? --Peterson

DEAR PETERSON: You bought real estate and plan to sell it now. Accordingly, you may have to pay capital gains tax. You have to take your original purchase price, and add such items as improvements and any closing costs you paid when you bought the unit. This is known as the adjusted basis for tax purposes.

You then have to determine the adjusted selling price. You compute this by taking the sales price, less commissions and any closing costs. Subtract the adjusted basis from the selling price to determine your gain.

If you have lived and owned the property for two out of the five years before it is sold, you can exclude up to $250,000 of this gain. If you are married and file a joint tax return with your wife, the exclusion increases to up to $500,000.

This is quite simplified, but you should consult a tax adviser to assist you with your specifics.

DEAR BENNY: I thought this might be an interesting possibility to address in your column. Our primary residence has a $245,000, 15-year first mortgage with 12 years remaining at a fixed rate of 5.75 percent and monthly payments of approximately $2,500. We have been in the home for 23 years and have a HELOC of $425,000 available. Even in today's market the home is worth over $1 million.

We can use the line of credit to pay off our first mortgage and obtain a fixed rate of 4.1 percent, cost free, amortized over 20 years. Our plan is to add $1,000 a month as principal reduction to the required $1,500 loan payment, thus paying the same as before and paying off the loan in 12 years. ...CONTINUED

Is there anything wrong with this plan? We would still have over $100,000 remaining in the HELOC for emergencies as well as personal savings. --Herb

DEAR HERB: That's an interesting approach, but I see one potential hitch. Where can you get a fixed-rate loan at 4.1 percent cost-free? Have you been given a loan commitment for such a loan? Do you need tax deductions? If so, why not just keep your two loans? The way I read your question, you really are not saving anything: Either way, you will pay off the loans in 12 years, but not get the same tax deductions.